Bucking the Market: Three Contrarian Stock Picks for 2011

Investors who are tired of watching their portfolios oscillate up and down without making any firm gains this year due to market volatility may want to consider allocating a portion of their assets to a contrarian stock-picking strategy for next year. While contrarian investing is more risky than relying on index funds, the payoff can be far more rewarding.

Contrarian investing seeks to profit by moving against market trends, or going against the conventional wisdom of market sentiment. For example, contrarians believe that when a stock or a sector gets beaten down, prices often become artificially low -- making that the perfect time to go contrary to the market and bet on them making a comeback.

Don Hodges, chairman of Hodges Capital Management, uses a contrarian style of investing across his Hodges Small Cap (HDPSX) and Hodges Pure Contrarian (HDPCX) funds. After targeting an out-of-favor company, Hodges looks at the company's fundamentals, and talks to its competitors and customers to determine if it can survive whatever has bought its stock down. If a company has good management, is relatively debt free, has profits that are trending upward, and there are credible reasons why it can turn itself around, he may take a significant position in its stock.

"They don't all work, but the ones that work, work big," says Hodges, "And you get a good rate of return."

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Hodges' contrarian thinking led him to buy airline stocks last year and newspaper stocks two years ago when both sectors were out of favor. He bought A.H. Belo (AHC), parent company of the Dallas Morning News, when it was slightly above $1 a share two years ago: The stock has recovered to above $7 a share this year. Hodges said his firm valued A.H. Belo stock at about $12 a share before they bought it because the company was debt-free and owned significant real estate in Dallas.

"We bought 1.1 million shares, so we own more than 5% of the company now, and the stock is doing well and earning money," he says.

Stock picks like that have helped the Hodges Small Cap Fund capture returns of 15.28% so far in 2010. The Hodges Pure Contrarian Fund is up 6.26%. By contrast, the S&P 500 is up just 2.31% year-to-date.

In Hodges' contrarian thinking, the following stocks could do quite well over the next 24 months:

• Furniture Brands (FBN) – Not many people are buying furniture in the middle of a housing crisis, when foreclosure rates are at record highs, but Furniture Brands carries many of the leading brands of furniture in the country, so when the housing market recovers, chances are, the company will too. Hodges says the stock, which closed Tuesday at $5.41 could easily reach $15 per share in two or three years.

• G-III Apparel Group (GIII) – This manufacturer of women's leather clothing found a way to win contracts to manufacture private-label clothing for major companies including Calvin Klein, Sean John, Kenneth Cole, Cole Haan, Guess?, Jones New York and Nine West. In an environment in which manufacturing has slowed, they've recently expanded and have made women's dresses a specialty. The stock closed Tuesday at $31.49.

"With two or three years of good performance, it could be a $40 to $45 stock," says Hodges.

• Kansas City Southern Railroad (KSU) – This railroad company saw its stock price hammered after storms washed out a significant portion of its tracks in Mexico last year. Hodges sees it as a takeover target because it's strategically located in the center of the United States, stretching from Mexico through Houston, Kansas City and up into Canada. The stock closed Tuesday at $38.40.

"If Burlington Northern or Union Pacific (UNP) wanted to acquire Kansas City Southern, they wouldn't be in competition ... it would be broadening their route structure," Hodges reasons. "I can see it at $60, maybe even $65 in a couple of years."